Since the commencement of the Trump administration, the world has witnessed a surge in criticism of investor-state dispute settlement mechanisms. Critics describe the system as infringing upon the rights of sovereign states to regulate matters of health, safety and environment, within their own territories. They criticize the system for allowing foreign corporations to sue states for adverse regulation even if the regulation is there to protect matters of vital public concern. Finally, critics accuse the system of being biased towards investors and hostile towards developing states.

In May 2015, Lise Johnson and Lisa Sachs of the Columbia Centre on Sustainable Development in the US published a policy paper in which they conclude that investor-state dispute settlement mechanism - ISDS - cannot be used for anything but evil:

“Multinational companies are increasingly using ISDS to challenge the legal and regulatory systems and policy choices of the contracting states, posing a serious and growing risk to the ability of states to govern in the public interest.

ISDS is a mechanism that allows foreign individuals and foreign companies to sue host country governments through ad hoc arbitration proceedings rather than through normal domestic administrative and judicial channels.” 1

The grievances that the critics level at ISDS are premised on the early generation of investment treaties. Indeed, with the first Bilateral Investment Treaty (BIT) concluded between Germany and Pakistan in 1958, investment law at the time addressed a global need to provide open-textured protection to foreign investors in fragile jurisdictions.

Without the open-textured, investor-friendly treaties in the wake of the Second World War, foreign direct investment would have been too costly, as it would have reflected the price the foreign investors would have had to pay as a result of high sovereign risk. The early investment treaties were thus negotiated and drafted on that basis. Those early BITs served their purpose, and along the way, they generated a body of case law that may be perceived as investor-friendly. That, in turn, has fueled the current ISDS backlash.

Ironically, the backlash targets contemporary, balanced, sophisticated investment treaties rather than the first generation of BITs. In 2015-2016, when the text of the TPP was being negotiated, the ISDS criticism turned from mild to vile. In an interview to Huffington Post on 10 June 2015, a Foley Hoag partner whose main practice area is investor-state dispute settlement described ISDS as “rogue”:

“I had absolutely no idea this was coming,” Parada said. Sitting in a glass-walled meeting room in his offices, at the law firm Foley Hoag, he paused, searching for the right word to describe what has happened in his field. “Rogue,” he decided, finally. “I think the investor-state arbitration system was created with good intentions, but in practice it has gone completely rogue.”

When ISDS cases were brought against states under early-generation BITs, the arbitrators deciding these claims were required to interpret protections that were drafted in broad, open-textured terms and for which the State’s main defences lay in customary international law, rather than the text of the BIT. This gave ISDS arbitrators considerable flexibility to determine the meaning of the protections at issue and how they applied to the facts of the dispute at hand.

The disputes that have been brought against the states under the first generation of bilateral investment treaties would, therefore, often find that adverse regulation by the states in an attempt to protect health, safety, and the environment, would constitute expropriation.

Ever since the first cases were brought under NAFTA, there has been a growing concern that the treaties’ prohibition of indirect expropriation might apply to regulatory measures aimed at protecting the environment, health and other welfare interests of society. At the very least, the tribunals seized with deciding those disputes would find the states liable for breaches of Fair and Equitable Treatment standards in the applicable treaties.

In S.D. Myers v Canada, the tribunal was appointed to decide whether Canada’s hazardous waste regulation was justified by environmental considerations. The tribunal decided that Canada’s measure that affected the claimant investor’s property was introduced for the primary purpose of protecting the interests of Canada’s waste disposal industry. It followed that the measure was in breach of Canada’s obligations under NAFTA. This finding was made despite NAFTA’s environmental exemption that excluded environmental focused measures from the scope of the treaty’s expropriation provisions:

“Nothing in this Chapter shall be construed to prevent a Party from adopting, maintaining, or enforcing any measure, otherwise consistent with this Chapter, that it considers appropriate to ensure that the investment activity in its territory is undertaken in a manner sensitive to environmental concerns.”2

“Expropriatory environmental measures – no matter how laudable and how beneficial to society as a whole – are in this respect, similar to any other expropriatory measures that a state may take in order to implement its policies: where property is expropriated, even for environmental purposes, whether domestic or international, the state’s obligation to pay compensation remains.”3

The tendency of tribunals in similar cases has been to read down the effect of environmental provisions, thus preserving the original basis of these treaties as investment protection treaties.

II. Response to the Backlash

A line of academic thought has developed in response to that trend, largely in defence of the state’s regulatory space. Ian Brownlie argues in his “Public International Law” treatise that

“state measures, prima facie a lawful exercise of powers of governments, may affect foreign interests considerably without amounting to expropriation. Thus, foreign assets and their use may be subjected to taxation, trade restrictions involving licenses and quotas, or measures of devaluation. While special facts may alter cases, in principle such measures are not unlawful and do not constitute expropriation.” 4

Professor Sornarajah, an avid adept of the Third World Approaches to International Law (TWAIL) movement, finds that interference on the basis of environmental, health, and safety legislation does not constitute compensable taking in situations in which public harm has already resulted or is anticipated. He also finds that to pay compensation would be to reward a wrongdoer or to recognise an absence of overwhelming public interest in the use of property.5

In his “The International Law on Foreign Investment”, Professor Sornarajah finds the Santa Elena v Costa Rica dictum to be outdated in the context of general international law and concerns for the environment. Indeed, measures taken to protect the host states from harm arising from environmental situations would be considered regulatory expropriations.

In his view, environmental degradation caused by a foreign investor would justify measures taken by the state. Where a treaty provides for environmental exceptions and carve-outs, such regulatory measures by the state will not amount to compensable expropriation and will not violate investment protection standards such as fair and equitable treatment. He goes as far as to say that even where the environmental carve-outs are not part of the treaties, they could be read into the treaties as part of international law.6

Fortunately for foreign investors and their counsel, Professor Sornarajah’s views on the role of environmental regulation in investment law are countered by a number of treaty scholars and arbitrators. Charles Brower, at a seminar held in 2000 at the Permanent Court of Arbitration, explained that from an investor’s perspective, any attempt to lower the traditional customary standards of investment protection based on the nature of the particular public purpose for which the taking was effected, would increase the risk (and therefore ultimately the cost) of investing abroad, if not altogether foreclose foreign investment.7

While Professor Sornarajah and Professor Brower test their conflicting views in academia and in practice, tribunals seized of treaty disputes arising out of environmental measures are largely guided by the wording of the underlying treaty. Thus, it is the words of the underlying treaties that decide the fate of the state’s environmental regulatory space in contemporary investment law. Where the treaty contains no environmental exceptions or carve-outs, it is patently difficult for any treaty tribunal to find that adverse environmental legislation does not constitute compensable taking.

The body of investor-friendly case law that has emerged in the last decade is reflective of the lack of environmental exceptions and carve-outs in the treaties under which the disputes were brought. Fortunately for developing states, the winds of change seem to be sweeping away the risk of the state’s international liability being engaged in matters of environmental regulation.

III. Treaty-based Environmental Carve-outs

Increasingly, contemporary investment treaties and free trade agreements with investment chapters include carve-outs and exceptions that address the effects of investment protections on the host state. These carve-outs and exceptions seek an investment protection regime that would ensure long-term, sustainable development of the host states in the areas of health, safety, and the environment.

Dame Higgins framed the dilemma underlying the debate over investment protection versus conservation of the states’ regulatory powers by asking a question: “who is to pay the economic cost of attending to the public interest involved in the measure in question – is it to be society as a whole, represented by the state, or the owner of the affected property?”8

The answer to Dame Higgins’s dilemma in the context of modern treaty-making is in treaty-based environmental carve-outs and exceptions. The trend to include environmental carve-outs in contemporary treaties - the “green treaty-making” – is the trend towards expressly conditioning investment protection rights and duties to ensure the host state can legitimately regulate in the area of environmental protection without exposing itself to liability under the treaty.

As part of the Hong Kong–ASEAN FTA, the negotiating member-states concluded an Investment Agreement which provides, in Annex 2 (Expropriation and Compensation), that:

“non-discriminatory regulatory actions by a Party that are designed and applied to achieve legitimate public welfare objectives, such as the protection of public health, safety, and the environment, do not constitute expropriation”.

Thus, adverse regulation that negatively affects foreign investors but is designed to protect public health, safety, and the environment, is unlikely to constitute compensable taking under Hong Kong’s treaty with ASEAN.

The treaty’s language can be easily traced to a similar provision in the Trans-Pacific Partnership Agreement (both the initial version of it, as well as the 11-partite version signed by the remaining member-states in Santiago in March 2018):

“Non-discriminatory regulatory actions by a Party that are designed and applied to protect legitimate public welfare objectives, such as public health,37 safety and the environment, do not constitute indirect expropriations, except in rare circumstance (Annex 9-B (Expropriation)).”

Hong Kong’s environmentally-friendly treaty is in line with China’s contemporary treaty-making policy. Expropriation Annex of RCEP’s draft Investment Chapter [October 2015] traces that wording and excludes regulatory measures from the scope of its expropriation provisions:

“non-discriminatory regulatory measures by a Party or measures or awards by judicial bodies of a Party that are designed and applied interest or public welfare objectives, such as public health, safety, and the environment, shall not constitute expropriation/s under this Article.”

V. Conclusion

Environmental concerns have long been on the global political agenda. These concerns are linked to the global concern for economic development. The latest treaty-making practice, in particular in China and in Hong Kong, is a testament to that relationship of dependence: while states are willing to facilitate foreign direct investment by concluding investment treaties and free trade agreements with investment chapters, they limit the scope of investment treaty protection by carving out measures that are designed to protect the environment.

As Indira Gandhi asked at the 1972 UN Conference on Human Environment: “Are not poverty and need the greatest polluters”? The answer to Gandhi’s rhetorical question, as well as to Dame Higgins’s dilemma, lies in the development of treaty-based environmental carve-outs and exceptions, and Hong Kong is again at the forefront of that development.

5. M. Sornarajah, The International Law on Foreign Investment, Oxford University Press, 2004, pp.357-356

6. Ibid, pp.472-473.

7. C. Brower and E. Hellbeck, “The Implications of National and International Environmental Obligations for Foreign Investment Protection Standards, Including Valuation: A report from the front lines”, Kluwer Law International, 2000, p21.

Ms. Boltenko is a registered foreign lawyer with Fangda Partners in Hong Kong. She specialises in investment arbitration. She has acted as legal counsel in investor-state disputes under the auspices of the Permanent Court of Arbitration, and as tribunal secretary in dozens of commercial disputes, both ad hoc and institutional (including SIAC, ICC, HKIAC, SCC), in a wide array of industries including oil and gas, infrastructure, construction, telecommunications and pharmaceuticals. She is an adjunct lecturer at the University of Hong Kong. She chairs the ICC Hong Kong Commercial Law and Practice Committee. She is listed as arbitrator on the HKIAC list of arbitrators, and on the AIAC, SIAC, and CIETAC panels of arbitrators.